Bond Yield Implied Inflation

Bond market implied inflation is derived by comparing the forward yield curves difference between normal fixed coupon bonds and CPI index bonds. In the former the nominal yield is the market return for real interest term risk and inflation, while in the latter the inflation indexing means that the bond yield is the real interest only.

Select a date to compare yield curves the nominal (Fixed Coupon Bond) and real (Inflation/CPI Indexed Bond) yield curves.

Yield curve for . Details of the interpolation of traded bond yields is available here.

Where observed nominal and real interest rates are available, the implied inflation rate is derived using the the Fischer equation:

Hence an estimated of the expected inflation is derived as the difference between the nominal (coupon bond yield) and real (inflation indexed coupon bond yield) interest rates:

The implied inflation forecast can be extract from the spot or forward yield curve, where the spot represents the average inflation over the period and the instantenous forward represents the implied annualised inflation rate at the horizon. The implied inflation forecast for the was:

Of note, beyond a certain horizon, inflation risk has a material impact on bond spreads. Inflation index bonds demand a lower real spread as the indexation insulates a long term bond investor from inflation uncertainty.

A comparison betwen short end inflation forecasts and the RBA survey of market economists inflation forecasts is provided below along with the historical trends in market implied inflation. Prior to 2020 there was persistent expectations of disinflation (negative inflation) which meant the market often implied quite low spreads for fixed coupon bonds. Since 20222 as inflation pressures have increased market implied spreads have widen considerably.